Did you know that over 3400 new borrowers took out a reverse mortgage in the year 2014? At the end of December 2014, there were over 40,000 reverse mortgages on issue in Australia, with an average loan size of $92,000.
A reverse mortgage allows you to use the equity in your house as collateral for a loan that you could borrow in a lump sum, or as a regular stream of income, or a mix of both.
Meant for aged and retired people, most banks require borrowers to be 60 years old or above to take out a reverse mortgage on their property.
The loan amount is repaid only when you move out of the house or die, which means the interest on the loan accumulates and is added to the total loan amount while you reside in the house. On your moving out or death, the house will be sold to pay off the debt.
Reverse mortgage features
1. The older you are, the more you can borrow
Most lenders allow you to borrow up to 15-20% of the total value of the house if you are over 60 years of age.
2. The loan comes at a fee
An application fee is payable, and you maybe charged interest at a rate that is 1-2% above the market rate.
3. As you age, the equity in the home reduces
If the move is not a well-planned one, you may not have much equity left over as you age.
4. You are protected
As per the negative equity protection introduced by the government in September 2012, the total debt amount cannot exceed the total market value of the house. In the event that your house reaps more than the market price, the extra funds belong to you.
Samantha and Nick decide to celebrate their senior years in style by going on a Mediterranean cruise for their 35th wedding anniversary. They own an expansive $4 million house in NSW and decide to take out a reverse mortgage of $800,000 at an interest rate of 7% to fund the trip.
Taking upfront costs to be $2000, Samantha and Nick calculate that they would owe $1,134,100 after five years. In another 15 years, the equity in the house would fall to about 59% and their mortgage debt would rise to $3,239,068.
This case study shows that debt increases significantly over time and can quickly outgrow the equity in a house. In the event that happens, the ‘no negative’ guarantee applies to protect the borrower by not allowing the debt to exceed the market price of the house.
Should you opt for a reverse mortgage?
Many retirees and seniors in Australia use reverse mortgages to supplement their income, repay existing debts, renovate or even take an exotic holiday. Some also use the loan to pay off accommodation charges for entry into aged care homes later in life.
Indeed, it is not a bad idea to build equity in your younger years and use it to fund your lifestyle as you age. However, before you decide that taking out a reverse mortgage is the right solution to support you, you should:
- Consider your future financial requirements
- Keep in mind the emotional implications of the decision – for instance, it may mean that you have less inheritance to pass on to your heirs – and communicate with your children in advance
- Use reverse mortgage calculators online to fully understand the financial implications of the loan
- Decide on the method of payout wisely, as a lump sum payment may be treated as an asset and affect your pension payout.